DR Barton of Trader's U: What Investors Can Learn From Traders

I'd like to share with you an insightful article by DR Barton of Traders U...

What Investors Can Learn From Traders
by D.R. Barton, Jr.
President, Trader’s U

Investors and traders really aren't that different, deep down inside. In general, traders think a little more highly of themselves. And they tend to buy and sell a bit more frequently.

And while I know a few traders who believe that they can leap tall buildings in a single bound, I have yet to see one of them actually demonstrate this particular attribute...

There are some generalities that we could use to distinguish traders and investors:

Traders tend to have shorter time horizons; investors have longer ones.

Investors lean more toward fundamental analysis, while traders concentrate more on technical analysis.

Traders have sharper wits and tend to be snappier dressers (okay - I just made that one up).

A trader's tendencies toward shorter time frames and technically based analysis can actually prove beneficial for investors as they apply fundamental analysis over longer time frames. Let's look at a few ways that a trader's mindset can help an investor.

Teaching Old Investors New Tricks

Traders, as a group, tend to be very open to learning new and better ways to do things. This is one characteristic that investors could profitably adopt. What are some concepts that traders apply that investors could use? Here are three that could help you in both your trading and investing portfolios:

Keep a healthy detachment. Investors, by the nature of their typically fundamental research, tend to get attached to their investment ideas. This is easy to understand. After doing copious amounts of digging into the balance sheet, management team and new-product stream of a prospective company, it's easy to buy into the story you've created about how good the company is. The problem is that many investors have trouble "letting go " when their pet stock doesn't work out and heads into the tank.

People will make all sorts of rationalizations to keep from selling a stock that they have spent so much time researching. You fall in love with the stock that you spent so much time and energy selling yourself on in the first place. Some might call it getting drunk on your own wine. But such attachment can be costly if it means holding onto a loser too long (or holding onto a stock that has had a great run for you and is now taking back most of those profits).

In contrast, traders must learn to give up the losers so they can go and concentrate on something more productive. The stock or commodity isn't personified; it either acts like it's expected to, or it's cut loose.

Take real responsibility for your results. It's easy to blame outside forces when an investment goes bad. Corporate insiders messed up. Short sellers knocked your stock down. Foreign (or domestic) oil barons played with the market. Your broker gave a bad fill. This list could be endless.

The problem is that until we take responsibility for the performance of our portfolio, we are destined to keep repeating old mistakes. If our most recent loss (or string of losses) was someone else's fault, why should we change anything? In order to make useful changes to our investing process, we have to take responsibility for losers and winners.

Are traders naturally more responsible people? Goodness, no! BUT traders have to learn to take responsibility early in their careers. We have a very descriptive word for traders who fail to take responsibility for their results - we call them "broke."

Manage trade-by-trade and portfolio risk. When investing, it is sometimes easy to get caught up in one good idea - like a company that could skyrocket 10 or 100 times its current price if it makes it through clinical trials or lands that critical contract. Even savvy investors who would never "risk it all" can catch themselves putting too many eggs in one basket when a particularly compelling idea comes along.

Because of the frequency of trading opportunities, traders are forced to manage trade-by-trade risk or face quick extinction. This is a hard lesson that many an aspiring trader has learned the hard way. Risking too much, too often, can rapidly knock a trader's equity below the point of no return.

A good rule of thumb for both traders and investors is to risk no more than 1% of your equity on any trade. This insures that you'll always be able to come back another day if your investment or trade doesn't work out.

As for your whole portfolio, lots of people don't even consider what could happen if a major event happened that affected a broad range of holdings in their portfolio. This is such an important topic, that we'll dedicate a whole article to it in the near future. For now, ask yourself this question: "How bad a hit would I take if all my stops were triggered in one day?" If the answer is not cataclysmic, you are probably on the right track.

Traders and investors are definitely similar in one aspect: Both are trying to profitably navigate the ebbs and flows of the market. Looking at the markets from another point of view may provide some valuable insight for you as pick your next trade or investment.